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2012 Estate Tax Planning Landscape Overview

2012 Estate Tax Planning Landscape Overview. Presented by: Justin Ransome and Robert Perez AICPA Trust, Estate, and Gift Tax Technical Resource Panel. NOTE: This is an audio only event. The presentation will stream through your computer, so please make sure your speakers are on.

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2012 Estate Tax Planning Landscape Overview

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  1. 2012 Estate Tax Planning Landscape Overview Presented by: Justin Ransome and Robert Perez AICPA Trust, Estate, and Gift Tax Technical Resource Panel NOTE: This is an audio only event. The presentation will stream through your computer, so please make sure your speakers are on. If you prefer to listen by phone, call 1-877-456-7681 and, when prompted, enter conference code 4213578915. The views expressed by the presenters do not necessarily represent the views, positions, or opinions of the AICPA or the presenter’s respective organization. These materials, and oral presentation accompanying them, are for educational purposes only and do not constitute accounting or legal advice or create an accountant-client or attorney-client relationship.

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  4. Speakers' Biographies • Robert Perez • Principal Shareholder • Robert Perez LLC • AICPA Trust, Estate, and Gift Tax Technical Resource Panel Member • Justin Ransome • Partner, Washington National Tax Office • Grant Thornton LLP • AICPA Trust, Estate, and Gift Tax Technical Resource Panel Past Chair

  5. Agenda • Transfer Taxes in 2012 • Transfer Tax Planning Techniques • Planning Considerations in 2012

  6. Gift and Estate Tax – rates and exemption • Gift and estate tax are re-unified • Top marginal gift and estate tax rate is 35 percent • Amount exempt from gift and estate tax is $5 million • Portable between spouses • Indexed for inflation beginning in 2012 (5.12 million)

  7. Applicable exclusion amount is sum of "basic exclusion amount" and "deceased spousal unused exclusion amount" (DSUEA) Basic exclusion amount is $5 million, indexed for inflation beginning in 2012 ($5.12 million) DSUEA is lesser of Basic exclusion amount or Excess of Basic exclusion amount of last deceased spouse over Amount with respect to which tentative estate tax is determined on estate of that spouse Gift and Estate Tax – portability

  8. Susan and John are married and live in a noncommunity property state. Susan has assets of $2 million in her name, and John has assets of $7 million in his name. They have no joint assets and neither has made any taxable gifts. Susan dies in 2011 and leaves her assets to their children. John's DSUEA is $3 million – the lesser of: Basic exclusion amount with regard to Susan of $5 million or The excess of $5 million over sum of Susan's taxable estate of $2 million and adjusted taxable gifts of zero If John dies in 2012, applicable exclusion amount is $8 million Gift and Estate Tax – portability

  9. Advantage of portability is it eliminates necessity to try to equalize estates of two spouses If poorer spouse dies first, that spouse's unused exclusion amount is not wasted As tempting as it may be to avoid effort to equalize, it is still a necessity until portability becomes permanent As of now portability applies only if first spouse dies after January 1, 2011 and surviving spouse makes gifts or dies before December 31, 2012 Portability does not apply for GSTT purposes Gift and Estate Tax – portability

  10. If 2010 Act sunsets and estate tax reverts to maximum rate of 55 percent and exemption amount of $1 million, question arises whether taxpayer who made gifts in 2011 and 2012 lose benefit of $5 million exclusion amount upon death Question revolves around what credit amount is to be used in computing gift tax payable Under 2010 Act, it is amount as of date of death Under prior law, it is as of date of gift After 2001 Act sunsets, Code is to be administered as if 2001 Act "had never been enacted" Thus, credit was never more than $345,800 Gift and Estate Tax – clawback

  11. Generation-Skipping Transfer Tax • Tax rate is 35 percent • GST exemption is $5 million • GST exemption is indexed for inflation starting in 2012 ($5.12 million) • Not portable between spouses • 2001 Act provisions preserved • Automatic allocations to indirect skips • 9100 relief for missed allocations and elections • Retroactive allocations for unnatural orders of death • Trust severances for GST tax purposes

  12. Transfer Tax Status 2009-2013

  13. Agenda • Transfer Taxes in 2012 • Transfer Tax Planning Techniques • Planning Considerations in 2012

  14. Transfer Tax Planning Techniques • Outright Gift • Family Limited Partnership (FLP) • Grantor Retained Annuity Trust (GRAT) • Sales to Intentionally Defective Grantor Trust (Sale to IDGT)

  15. Individuals may give up to $13,000 annually without gift tax consequences In 2012, an individual may make taxable gifts of $5.12 million during life before incurring a gift tax liability Outright Gift – overview

  16. Outright Gift – advantages • True freeze technique • Removes income and appreciation on gifted property from estate • Gifts are tax-exclusive (i.e., value of gift does not include value of tax)

  17. Outright Gift – example • Evan is divorced and has four children • He has an estate worth $55 million in 2012 • Evan gives each of his children assets worth $1.25 million • Evan dies in 2021 • Assume that amount excluded from estate tax returns to $1 million in 2020 and maximum estate tax rate is 55% • Assume assets grow at 7% per year after tax

  18. Outright Gift – example Do Nothing Gift Gross Estate in 2021 $101,115,257 $91,922,961 Estate Tax $55,267,591$50,916,829 Net Estate $45,847,666 $41,006,132 Gift in 2012 $9,192,296 Total Estate $50,198,428 Benefit of Outright Gift $4,350,762

  19. FLP FLP Senior Family Members 1. Assets 2. Limited & General Interests 3. Limited Interest Junior Family Members

  20. FLP – overview • Partnership created to facilitate transfer of wealth from one generation to next generation • Transfer tax benefit of creating FLP is reduction in gift/estate tax value of assets transferred to FLP when such assets are ultimately transferred to younger generations • Reduction in value is result of discounts associated with transfer of limited interests in FLP • Applicable discounts include minority interest, lack of marketability and/or lack of control • High IRS scrutiny

  21. Control over assets and distributions Simplifies gift-giving and management of estate Investment flexibility and efficiency Asset protection Valuation discounts FLP – advantages

  22. FLP – example • Evan is divorced and has four children • He has an estate worth $55 million in 2012 • Evan transfers $8 million of assets to a family LLC and gives each of his children a $1.25 million interest in LLC valued based on 37.5% discounts • Evan dies in 2021 • Assume that amount excluded from estate tax returns to $1 million in 2021 and maximum estate tax rate is 55% • Assume assets grow at 7% per year after tax

  23. FLP – example Do NothingGift of LLC Gross Estate in 2021 $101,115,257 $86,407,583 Estate Tax $55,267,591$47,883,371 Net Estate $45,847,666 $38,524,212 Gift in 2012 (no discount) $14,707,674 Total Estate $53,231,886 Benefit of Gift of LLC $7,384,220

  24. GRAT GRAT Parents 1. Property 2. Income Interest 3. Remainder Interest Children

  25. Estate freeze technique used to transfer appreciation of assets in excess of section 7520 rate to younger generations Value of retained interest reduces value of transfer to GRAT for gift tax purposes Value of retained interest may be set equal to value of assets transferred to GRAT ("zero out") and, thus, there would be no gift tax consequences of transfer to GRAT GRAT – overview

  26. To extent assets transferred to GRAT appreciate at a rate in excess of section 7520 rate over annuity term, such “excess” appreciation inures to benefit of remainder beneficiaries free of additional transfer tax Because a GRAT is a “grantor trust” for income tax purposes, all income tax consequences associated with GRAT are responsibility of grantor, therefore preserving assets in GRAT that will ultimately pass to remainder beneficiaries GRAT – advantages

  27. Section 7520 rate (120% of mid-term applicable federal rate) for month in which transfer is made to GRAT is “hurdle rate” which assets have to beat in order for GRAT to produce an estate tax benefit As interest rates rise, all other factors remaining same, benefit of GRAT decreases $55M transfer, 5M gift, 9 year annuity term, 7% appreciation RateAmount Removed from Estate 1.2% $30,514,709 2.4% $26,333,439 4.8% $17,605,401 GRAT – interest rates

  28. GRAT – example • Evan is divorced and has four children • He has an estate worth $55 million in 2012 • Evan transfers all his assets to a family LLC • Evan transfers his entire interest in LLC to a GRAT with a term of 9 years and a $5,000,000 present value remainder interest (based on a 37.5% discount and section 7520 rate of 1.2% (for July 2012)) which will be distributed to his children upon termination of annuity interest – Evan will receive an annuity of $3,462,852 ($5,540,653 undiscounted) per year • Evan dies in 2021 • Assume that amount excluded from estate tax returns to $1 million in 2021 and maximum estate tax rate is 55% • Assume assets grow at 7% per year after tax

  29. GRAT – example Do NothingGRAT Gross Estate in 2021 $101,115,257 $66,364,743 Estate Tax $55,267,591$36,859,809 Net Estate $45,847,666 $29,504,934 GRAT in 2012 $34,750,514 Total Estate $64,255,448 Benefit of GRAT $18,407,782

  30. Sale to IDGT 1. Gift “Seed” Property IDGT Parents 2. Assets 3. Note 4. Interest Payments 5. Remainder Interest Children/ Grandchildren

  31. Estate freeze technique that involves sale of assets to an “intentionally defective grantor trust” for an installment note Installment note generally set for a term of 5 to 9 years and interest rate set at section 7872 rate commensurate with term of installment note Because IDGT is a disregarded entity for income tax purposes, sale does not trigger income tax consequences Sale to IDGT – overview

  32. Removes appreciation in excess of section 7872 rate from grantor’s estate without additional transfer tax consequences Greater wealth transfer benefit if property sold to IDGT is discounted property and distributions from discounted property can service installment note Excellent vehicle to transfer wealth to grandchildren and younger generations Sale to IDGT – advantages

  33. Applicable federal rate for month in which sale takes place (commensurate with term of note) is “hurdle rate” which assets have to beat in order for Sale to IDGT to produce an estate tax benefit As interest rates rise, all other factors remaining same, benefit of Sale to IDGT decreases $5M gift, $50M sale, 9 year note, 7% appreciation RateAmount Removed from Estate 2% $39,137,268 4% $27,159,279 6% $15,181,290 Sale to IDGT – interest rates

  34. Sale to IDGT – example • Evan is divorced and has four children • He has an estate worth $55 million in 2012 • Evan transfers all his assets to a family LLC and gives a $1.25 million interest in LLC valued based on 37.5% discounts to a trust for benefit of each of his children • Evan sells remaining LLC interests to children’s trusts for a $29,375,000 9 year balloon note with interest at 0.92% (July 2012 mid-term AFR) per year • Evan dies in 2021 • Assume that amount excluded from estate tax returns to $1 million in 2021 and maximum estate tax rate is 55% • Assume assets grow at 7% per year after tax

  35. Sale to IDGT – example Do NothingGift and Sale Gross Estate in 2021 $101,115,257 $32,612,051 Estate Tax $55,267,591$18,295,828 Net Estate $45,847,666 $14,316,223 Gift and Sale in 2012 $68,503,206 Total Estate $82,819,429 Benefit of Sale to IDGT $36,971,763

  36. GRAT/Sale to IDGT – comparison Sale to IDGTGRATAdvantage Statutorily sanctioned No Yes GRAT Protection against revaluation No1 Yes GRAT Create without taxable gift Maybe2 Yes GRAT Protection if assets decline in value No Yes3 GRAT Grandchildren as beneficiaries Yes No Sale Able to terminate early Yes4 No Sale Balloon payment Yes No Sale Income tax consequences if grantor Possible5 No GRAT dies during note term Amount includible in estate if grantor Unpaid FMV Sale dies during term Principal of Trust 1. May use valuation clause to negate gift tax effect of revaluation 2. If seed gift in excess of credit amount 3. Assuming GRAT is “zeroed-out” 4. Note should allow for prepayment 5. Questionable whether death triggers gain if note still outstanding

  37. Comparison Outright GiftGift of LLCGRATSale to IDGT $91,922,961 $86,407,583 $66,364,743 $32,612,051 $50,916,829$47,883,371$36,859,809$18,295,828 $41,006,132 $38,524,212 $29,504,934 $14,316,223 $9,192,296$14,707,674$34,750,514$68,503,206 $50,198,428 $53,231,886$64,255,448 $82,819,429 $4,350,762 $7,384,220 $18,407,782 $36,971,763

  38. Agenda • Transfer Taxes in 2012 • Transfer Tax Planning Techniques • Planning Considerations in 2012

  39. Large Gift Interests in Closely-Held Family Business Grantor Retained Annuity Trust Sales to Intentionally Defective Grantor Trust Generation-Skipping Transfer Tax Planning Planning Considerations for 2012

  40. Amount exempt from gift tax jumped dramatically from $1 million to $5.12 million (for 2012) Increase may be only temporary – December 31, 2012 Gift tax rate is only 35 percent – may revert to maximum of 55 percent in 2013 Gifts during 2012 eliminate future appreciation in value of gifted property from transfer taxes Gift of $5 million in 2012 instead of in 2013 results in an instant gift tax savings of $2,045,000 ($2,111,000 if gift of $5.12 million) Large Gift

  41. Increased gift tax applicable exclusion amount of $5.12 million can be further leveraged by gifts of interests in closely-held family businesses valued using these discounts Discounts for minority interests and lack of marketability Legislative proposals to limit use of discounts for closely-held family businesses have not been enacted Discounts continue to be viable estate planning tool Even if discounts are legislatively restricted in future, donor has eliminated value representing discounted value from transfer taxes Interests in Closely-held Family Business

  42. GRATs continue to be valid estate planning tool for Wealthy individuals Individuals who may again be subject to estate taxes in 2013 and beyond Individuals who are subject to state estate taxes Current low AFR rates to value retained interest as well as low values for assets to be transferred to GRATs continue to make GRATs an important estate planning technique Legislative proposals to require a 10-year minimum term GRATs have not been enacted GRAT

  43. Seed money for sales to IDGTs Traditionally IDGT required to have 10 percent equity If funded with $1 million tax-free gift, $10 million of assets could be sold to IDGT Now increase funding by another $4 million tax-free gift, an additional $40 million can be sold to IDGT when section 7872 rates are currently low – 0.92 percent mid-term rate for July 2012 Additional gift to existing transaction to allow IDGT to pay off note President has provision in 2012 budget to eliminate benefits of IDGTs Sale to IDGT

  44. Utilize increased GST exemption of $5.12 million (for 2012) Create new trusts to which GST exemption may be allocated If created in state with no rule against perpetuities, trust can last forever Trust will always be exempt from GSTT Consider late allocation to trust that is non-exempt or partially exempt Remember that GST exemption is allocated to trust based on value of trust at date of late allocation Generation-Skipping Transfer Tax Planning

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